California Governor Gavin Newsom signed into law Assembly Bill 5 (“AB-5”). AB-5 codifies into California’s Labor Code the “ABC test” for determining employee or independent contractor status, as adopted by the California Supreme Court in Dynamex Operations West, Inc. v. Superior Court, 4 Cal.5th 9 (2018). Under the ABC test a person is an employee, not an independent contractor, unless (1) the work she performs is free from control of the hiring entity, (2) the work is outside the usual course of the hiring entity’s business, and (3) the worker is customarily engaged in an independent trade. All three elements must be met for independent contractor status. If an individual is an employee under AB-5, the California Labor Code, Unemployment Insurance Code, and California Industrial Welfare Commission Wage Orders apply.
The bill received attention as a political measure to protect gig economy workers. But it may have far reaching effects on franchising. Most franchisors can usually pass the first and third elements of the ABC test. But overcoming the second element, that the franchisee’s work is “outside the usual course of the hiring entity’s business,” is challenging. However, an entity franchisee is unlikely to be deemed an “employee” of a franchisor. This is because employees are individuals, not business entities.
AB-5 requires an employer to pay the expenses and losses incurred by an “employee” at the request of the employer. If classified improperly as an independent contractor, a franchisee could sue a franchisor to recover money spent running the franchise, including hiring employees, paying rent, and other operational costs, as employee expenses and losses. Franchisees may also apply for employment benefits as employees. The International Franchise Association lobbied the California legislature for a franchise exemption, but no such exemption was included.
Post-
Dynamex cases such as
Vasquez v. Jan Pro Franchising have held that the ABC test may apply to franchise relationships. A court following this reasoning could find that franchisors are employers of both their franchisees and their franchisees’ employees, if the relationship meets the ABC test.
Vasquez also held that the ABC test is retroactive, enabling wage and hour claims to encompass 4 years before the lawsuit is filed. The holding regarding retroactivity was withdrawn, but its core holding on the ABC test in the franchise model was reinstated. AB-5 states that certain provisions are retroactive “to the maximum extent permitted by law.”
AB-5 takes effect January 1, 2020. Proactive franchisors may wonder how to maintain existing commercial relationships and sell franchises without unintended liabilities of employers. Franchise counsel should be consulted to review controls in place for brand protection, and the flow of monies in certain systems to identify key risk factors under the ABC test.
